Back to M&A Resources | General

Why You Should Invest in Startups and How to Do It

 

Do you want to invest in startups? If so, it’s essential to do it the right way. It’s undeniable that there are risks associated with investing in a startup, but there are significant benefits as well.

At NorthStar Venture Partners, we believe in startups because we work with them every day. Here are some reasons why you should invest in startups -- and some pointers on how to do it to minimize your risk.

The Benefits of Investing in Startups

By definition, a startup isn’t a sure thing. New companies haven’t established themselves yet, and they may not have the revenue or customer base to deliver a big return on your investment.

That said, there are lots of reasons to consider investing in startups. Here are some of the biggest benefits.

  1. Getting in on the ground floor of a successful venture can add up to big financial rewards for you. A smart investment at the right time may translate to a huge return on your investment.
  2. Investing in a startup makes you part of economic growth because startup companies create jobs and contribute positively to the economy.
  3. Your startup investment can help you be a part of something exciting and innovative. While some investors take a passive role, people who invest in a startup in its early stages often take a hands-on approach, offering advice and perspective. If you want to be part of a team, then investing in startups is a good way to do it.
  4. A lot of startups are innovating in ways that have a big impact on the world. Getting involved with one is a good way to do something meaningful and let your investment make a difference.
  5. Finally, investing in a startup is a good way to diversify your portfolio. It’s never a good idea to put all your eggs in one basket!

Investing in startups can be fun, exciting and profitable. If you can afford it, it’s a great way to get involved in something that’s meaningful, too.

How to invest in Startups

Investing in startups can be lucrative and rewarding, but it’s important to approach it the right way. If you want to invest in startups, here are some tips to help you.

Don’t Skimp on Due Diligence

The first thing is not to skimp on due diligence. You shouldn’t be investing in a company if you haven’t looked at the business plan, evaluated a prototype, or talked to the people involved. You should also review the shareholder agreements, financial statements, and confirm that all IP is owned by the company before you proceed.

Protect Yourself Legally

When you invest in a startup, you’ll have the opportunity to do some things to protect your investment. Two of the most important are:

  • Stating your liquidation preference. You can specify that you will receive X times your initial investment before anyone else.
  • Including an anti-dilution clause. Anti-dilution says that the pre-money valuation of a startup cannot be lower than the post-money valuation of the previous round of investors.

It’s also a good idea to specify the role you will play in the startup and how/if that role will change in the event of a merger or acquisition.

Have the Right Mindset

Everyone who invests in a startup wants to make money, but the reality is that a high percentage of startups fail. You should have the mindset, going in, that your investment may not come back to you at all.

That might sound like a negative attitude, but it’s actually a realistic one. You may earn a big profit, but if you assume you will, the chances are good you’ll be disappointed. Managing your expectations can help you feel good about your investment.

Choose the Right Financial Instrument for Your Investment

When you’re enthusiastic about an investment, you may be tempted to write a check and hand it over without a second thought. Instead, familiarize yourself with some of the unique financial instruments that are designed for startup investors.

One of the best ways to invest in a startup is by granting a convertible loan. Convertible loans have interest which accrues over time and is later converted into shares of the startup. Early stage investors often get a specified discount on their shares. They may also place a cap on the share price to protect themselves if the value of shares explodes before the conversion.

Understand the Exit Strategy

Every startup should have a designated exit strategy that lists potential buyers and spells out how the exit will take place. If a startup hasn’t taken this step, then you should rethink your investment -- or, at the very least, insist that they create an exit strategy before you invest.

You might think it’s premature to make an exit strategy a criterion for investing, but things can move quickly when a startup takes off -- and your job is to protect your investment.

Conclusion

The key to investing in startups is to be smart and deliberate about it. By researching and taking some measures to protect your investment, you can make startup investments an important and lucrative part of your portfolio.

Need help with your next startup acquisition? Click here to work with NorthStar Venture Partners!

 

 

 

 

Julien Meyer

Written by Julien Meyer

NorthStar Venture Partners is led by Julien Meyer, MBA. A veteran of the tech community, Meyer is a 3x startup founder with 2 exits, a published author, a Harvard Business School Leading with Finance Alum and a Top Rated Startup Consultant (UpWork, 2018). Meyer advised on over 50 successful transactions before starting NorthStar. His experience has helped him understand the unique challenges that founders experience when trying to exit their ventures.